ABSTRACT
This chapter outlines the basic propositions behind welfare and trade theory and outlines the role of competition in the efficiency of markets. It summarises what traditional trade theory has to say about environmental aspects. According to standard trade theory there are two main reasons for comparative advantages: different endowments and different technologies. For the sake of trade analysis there is a need to differentiate two classes of externality. On the one hand are externalities that do not cross national borders. On the other hand, there are international spillovers, such as the 'greenhouse effect'. Free trade leads to a specialisation in polluting industries in countries with low or no environmental standards, and to a specialisation in clean industries in countries with high environmental standards. In a free-trade setting each agent and each country has an incentive to produce the goods for which it is relatively most competitive and to exchange the goods against other products on the world market.
